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Water under the bridge
British project provides pointers

John Chenery talks with Sir Ian Byatt

When the Thatcher government decided to privatize the water industry in England and Wales in 1988, it unleashed a storm of public criticism that has only recently started to subside. At the centre of the storm was Sir Ian Byatt, whose Office of Water Services (OFWAT) was responsible for overseeing water pricing, service and efficiency. Sir Ian stepped down as Director General of Water Services last year and earlier this year completed an extensive review of local government procurement in England called Delivering Better Services for Citizens. When visiting Toronto recently, he spoke to Summit about why he believes governments throughout the world will continue to relinquish service delivery to the private sector.

Summit: All levels of government in Canada are looking to the private sector to provide services that were once government responsibilities. Are there any aspects of the British privatization model that can be applied here?

Byatt: What happens in a particular situation depends on the institutional setting, history and prevailing attitudes. But some general lessons have come out of the UK experience. One is accountability and responsibility - deciding who's going to do what. In water, for example, it is clear that setting standards - drinking water quality and how wastewater is treated - is a job for [government] ministers who are democratically accountable, in our case within the European Union. We established quality regulators to ensure that companies meet those standards through a system of inspections and enforcement. OFWAT ensured that the companies carried out their business functions, setting price limits that enabled them to finance themselves, promoting efficiency and protecting customers. The clarity of who does what is important. Another lesson is the need for transparency. Instead of decisions being taken behind closed doors, everything is in the public domain. We've published huge amounts of information about the water industry so that people putting forward their point of view did so on an informed basis. We also learned that through privatization it was possible to achieve new, higher standards of drinking water quality and wastewater treatment and still make dramatic progress in efficiency and cost reduction.

Summit: During the changeover and for some time afterwards, there was intense criticism of the privatization process, of the water companies and of OFWAT.

Byatt: Nothing is ever achieved without criticism. What worried people initially was that in the first few years water prices went up quite significantly. That was necessary to finance the huge increase in the capital program. Investment in the industry doubled from about 1.5 billion to 3 billion a year and has remained fairly steady at that level since about 1990. That was bound to push bills up. More recently, we've seen the results of efficiency improvements and in 2000 were able to reduce bills by about 12 percent.

Summit: Speaking about transparency: it was within your power to make OFWAT's operations transparent, but didn't the water companies resist pressure to reveal confidential corporate information?

Byatt: The companies had to declare a lot of information to us. We took care to ensure that this was collected consistently across the country [to evaluate performance]. That information is publicly available. We publish summaries in our reports - also freely available - and we put all the basic data on a CD-ROM, for anyone who wants detailed information about the companies. [All this information] has helped in promoting an understanding of how environmental improvements, desirable though they may be, cost money. By demonstrating the cost and how this affects water bills, we've been able to encourage people to think in a cost-effective way.

Summit: Some critics of privatization suggested that OFWAT should have been more involved with the environmental aspects of water supply and wastewater disposal so that these could be included in its pricing deliberations.

Byatt: We were involved; not by having environmental responsibilities ourselves but by having a process whereby we took account of these issues. Each time we had a price review, I would write to the Secretary of State [for environment] describing possible environmental improvements and how much they would add to water bills and requesting information on new environmental obligations water companies would face during the next five years so that I could allow for these expenditures in setting prices. Ministers would reply in public. This open dialogue finished with [government] setting out the new environmental obligations. My job was to protect customers and to keep them from paying too much and to protect them against having to pay for obligations that were not cost-effective. A minister, advised by me on costs and by the environmental agency on benefits, decided what those obligations would be.

Summit: In your opinion, how much money is reasonable for a water company to make?

Byatt: We believe that an average return on capital of about five percent above the rate of inflation is reasonable over the medium term. We would set price limits for five years after applying our own efficiency factors to their projections, taking account of the costs of new obligations (not just relying on water company numbers, but adjusting them for the efficiencies we believed they could achieve) and then allowing a rate of return of about five per cent over that whole period. Some years they may make more, some years less. Indeed, if they could reduce their costs even further then they might make considerably more but in the next price review we hand those benefits over to the customer.

Summit: A lot of the water company projections regarding their investment in infrastructure didn't really pan out. Why was that? How did OFWAT deal with it?

Byatt: We realized that there was a tendency to overbid. In both price reviews we took a hard look at their capital expenditure estimates and concluded that they could fulfill their obligations with substantially less expenditure, both capital and current. What happened between 1995 and 2000 was interesting. We cut back their estimates and they did even better than projected, so there was some unexpected efficiency coming from the system - part of the reason we were able to introduce substantial price reductions in 2000.

Summit: Has privatization produced the level of investment in infrastructure that you thought was necessary at the outset?

Byatt: I don't know that I had a figure in my head that I thought was necessary. We tried to think more in terms of obligations that had to be achieved. The companies have achieved those obligations. Water quality has improved considerably. We have fulfilled all European Community objectives on wastewater, including much better beach quality. Of course that cost money and investment has doubled, but we've achieved the objectives.

Summit: On the question of competition in the UK water industry, critics claimed that from the consumer's point of view, nothing much has changed; you have merely replaced several semi-public water monopolies - the old regional water authorities - with private monopolies.

Byatt: It's true that the kind of competition we've achieved in electricity and gas has been slower coming in the case of water. However, there has been some success. We were able to achieve capital market competition. Each regional monopoly has to wash its face in the capital market and the pressure from financial analysts to perform better by getting costs down has been an important component of the increased efficiency. Competitive pressures in the financial markets have been very important. We encouraged the water companies to compete on customer service by publishing how well they did in that area. We've shown that an inefficient company can go out of business and be replaced by a more efficient one without any affect on customers - no supply disruption, no loss of water quality. But competition where the customer can choose a water supplier has been slow coming. Big users can decide to go to another company and prices for big water customers have come down. We believe that the kind of common carriage that has developed in electricity and gas could well develop in water, but there's a lot of work to do. Water is very heavy stuff and there are special quality issues to deal with. All the water companies must publish access codes. Anybody can use those pipes to transfer water from one place to another. So the market is potentially open, although no one has entered it yet.

Summit: What is going to happen when the current 25-year water licences expire? Will there be a flood of new companies wanting a piece of the action? How will that be handled?

Byatt: The government will have to decide what to do. They have to give the companies 10 years' notice if they are proposing to have another competition or introduce other changes. I presume that if the government did want to make changes then a major consultation would determine the new structure.

Summit: Are there a lot of international companies waiting to get into the water business in Britain?

Byatt: Most of the big international water companies are operating there now. Having a globalized water industry has, I believe, been an advantage; you get different expertise coming from different places. I wouldn't have believed 20 years ago that we could have a utility owned internationally.

Summit: How do you read the public view of privatization now? Is it a fact of life or do some suspicions still linger?

Byatt: I think it's now seen as a fact of life. It was quite unpopular at the time because people couldn't understand that private profit was compatible with public service. We've shown that it is. Water quality has gone up, customer service has improved and now we've had a customer dividend with the recent price reduction. The politics has not gone out of water; politics will never go out of water, and it shouldn't, but certainly the steam has subsided.

Summit: In Britain, privatization was one element of a radical agenda driven somewhat forcefully by Mrs. Thatcher. In the absence of similar political commitment in Canada, do you see any factors that could move privatization and public-private partnerships into the mainstream here?

Byatt: Part of the impetus in our case was the need to finance improvement - catching up with past neglect and then meeting new standards - both for drinking water and wastewater. I don't think that could have been financed from the public sector. In some theoretical world it could, but governments were not prepared to do that. The Labour government cut water investment in the 1970s and investment remained low until the private sector was brought in. Maybe - because of the state of government finances and budgets - the only way to get higher standards is to use private sector money. There are various ways to do that. We chose one route but in Scotland they have taken water away from the municipalities and put it into a public corporation using a private finance initiative to get capital for improvements.

Summit: Why have governments in many countries decided to get out of the business of borrowing money to finance infrastructure?

Byatt: In England it was a combination of two things: general pressure on the budget with never enough public money and the realization that the private sector is very good at raising money; and the belief that while it was important that governments control what is produced, there is no need for the government to produce everything. You can have very good public control of outcomes without the government doing it all. Privatization in its various forms is a way of achieving objectives more cost effectively.

Summit: Are there any areas that will always be handled by government? Could the private sector, for example, deliver health care in Britain?

Byatt: It depends what the people want, but it seems to me that the essential role of government is to decide what needs to be delivered. I've recently completed a report on local government procurement that concluded that the job of the local authority is to decide what gets provided to citizens, to make sure that it gets delivered and to maintain financial control over that process. They don't have to do the delivery. That can be outsourced in various ways. The public sector doesn't disappear; it concentrates on the political issues, the outcome issues. Norwegian patients now undergo surgery in Germany because there's a shortage of doctors in Norway and a surplus in Germany. We're thinking about that in England. But that's a delivery issue as opposed to a broader policy question such as whether health care should be free at point of entry. The people, through the electoral process, must decide those questions.

John Chenery has worked as a journalist and editor for national newspapers in Australia and the UK. Before moving to Toronto from Costa Rica, he was Director of Communications with the Earth Council.



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